This article is referencing surety bonds, specifically contract bonds, and setting up a bond facility; this is comparable to a subscription that enables you to provide bonds as a contractor throughout the year.
A bond facility is a pre-approved agreement between a contractor and a surety company. It provides contractors with quick access to required bonds (such as bid, performance, and labour & material payment bonds) without needing to undergo a lengthy approval process for each individual project.
It sets a maximum limit for the total amount of bonds the contractor can access for ongoing and future projects. This facility allows contractors to manage multiple projects efficiently while maintaining compliance with bonding requirements.
Setting up a Bond Facility is the first step in issuing the bonds that you need to perform the work that will take your construction business to the next level. A common annual bond facility cost is in the $3,000 range, but may be higher or lower depending on the underwriting complexity of your business.
Surety bonds are an essential safeguard in the construction industry, protecting project owners and ensuring that contractors fulfill their obligations. However, applying for surety bonds can be a complex process depending on the type of bond(s) and size of the project.
At Bond Connect, we’ve seen many common errors that can easily be avoided with the right guidance. So, before we go into detail about some of the common mistakes contractors make when applying for bonding – here are some tips that we call the 3 C’s of Surety to help to avoid these errors before they occur.
The 3 C's of Surety Bonds
Character
Character refers to the reputation and trustworthiness of the individual and/or business seeking the surety bond. It involves an evaluation of their track record, integrity, and history of fulfilling contractual obligations.
Surety companies assess the principal’s reputation within the industry and their willingness to adhere to ethical standards and contractual agreements.
Demonstrating good character increases the chances of being considered bondable.
Past successful projects, a solid credit history, and positive references from previous business partners all contribute to a strong character assessment.
Capacity
Capacity focuses on the principal’s ability to perform the duties outlined in the contract.
Surety companies analyze the principal’s experience, expertise, workforce, and equipment to ensure they possess the necessary capabilities to complete the project successfully.
For businesses, capacity evaluation may involve assessing their financial stability, management team, and operational efficiency.
Demonstrating a track record of handling similar projects and having adequate resources enhances the capacity rating, making the principal more likely to obtain a bond facility.
Capital
Capital refers to the financial strength and resources of the principal. It involves an assessment of their financial standing, liquidity, working capital, and overall ability to meet financial obligations.
Adequate capital ensures that the principal can handle unexpected challenges and complete the project even in adverse conditions.
A healthy financial statement, sufficient working capital, and manageable debt are key factors that increase bondability.
A financially stable principal is more likely to obtain a surety bond, as it signifies their ability to handle potential risks and fulfill their obligations.
Below we will go into more detail about some of the common errors and what types of problems they may cause. Be sure to keep the 3 C’s of Surety in mind, as these tips can help contractors to mitigate or even avoid these problems before they arise.
1. Applying as a new startup business with no capital
The minimum amount that is required for a start up to apply for and obtain a bond facility is $150,000 of working capital.
Working capital is a critical factor when applying for a bond facility because it reflects a contractor’s ability to meet short-term obligations and manage day-to-day operations effectively without worrying about cashflow.
Surety companies assess a contractor’s working capital to gauge financial stability and ensure that the contractor has sufficient liquidity to handle project demands, unexpected expenses, or delays. Some factors that may influence underwriters perception of your working capital may be:
- Lack of financial transparency (not disclosing liabilities, inconsistent revenue reports)
- Weak balance sheets or poor cash flow management
- Over-leveraging (high levels of debt)
- Receivables outstanding for 60+ days or longer
- No access to line of credit or banking relationship
Strong working capital demonstrates the contractor’s ability to manage cash flow, which reduces the surety’s risk and can lead to more favorable bonding terms.
Insufficient working capital, on the other hand, can lead to higher bond premiums or even denial of a bond facility at all.
2. Not having enough experience in your field of business
Having a proven history in your field of business is essential because it demonstrates your expertise, reliability, and ability to successfully complete similar projects.
A solid business history reduces the perceived risk for the surety, making it easier to qualify for bonds and negotiate better terms.
Surety companies evaluate this business history and a contractor’s experience in handling projects of similar size and complexity.
Listed below are some situations contractors are in when applying for a bond facility that may result in the denial of the application or higher premiums:
- Insufficient work history or experience with large-scale projects
- Overstating qualifications or experience without evidence
- Taking on a project that exceeds previous experience more than 2x largest contract
Contractors without sufficient experience may struggle to qualify for bonds. If you’re expanding into larger projects, consider partnering with more experienced contractors to build your track record. This demonstrates to surety providers that you can handle bigger scopes.
Please keep in mind that although your experience in an industry may have been with a previous employer; this still adds to your track record and is taken into consideration by underwriters when reviewing your submission.
3. Not maintaining quarterly internal bookkeeping
Surety underwriters assess a contractor’s financial health to determine risk. If contractors fail to provide clear financial records or have poor financial management practices, it can result in higher premiums or denial entirely.
Contractors with a bond facility are typically required to submit regular reports to the surety company. These reports offer insights into the contractor’s ongoing projects, financial status, and overall performance. The frequency of reporting may vary, but is often requested quarterly.
It is important to have the proper documentation in a timely manner. Some of the more common situations that cause issues for contractors are:
- Missing documentation (financial statements, work history, etc.)
- Providing outdated or incorrect information
- Being behind and not able to provide interim statements at all
Here are the types of financial statements that contractors will need to provide when applying for a bond facility.
- Balance Sheet
- Income Statement / Profit & Loss
- Aged Receivables Listing
- Aged Payables Listing
- Work on Hand (Work in Progress) Report
Ensure your financial documents are current and reflect your company’s most recent performance. Any inconsistencies or outdated information can raise red flags for underwriters which can result in delays and more questions.
4. Lack of accountant prepared year-end financial statements
Contractors with a bond facility must provide accountant-prepared financial statements at each year-end for their business.
These financial statements provide a comprehensive overview of the contractor’s financial health and stability, giving the surety company a clear picture of their capacity to take on additional work obligations, whether bonded or not.
By providing regular updates and financial statements, contractors can demonstrate their ability to manage multiple projects and fulfill their contracts on time. The year-end statements can be Compilation Engagement (Notice-to-reader), Review Engagement, or Audit reports.
Compilation Engagement Report
A financial statement prepared by an accountant based on the information provided by a business. Unlike audits or reviews, the accountant does not verify or provide assurance on the accuracy of the data.
Instead, they organize and present the information in the form of financial statements without necessarily expressing an opinion on its accuracy.
This type of report is typically used for internal purposes or by stakeholders who do not require a high level of assurance; therefore, it is the least effective in obtaining a bond facility.
It can still be done, but limits, rates, and general servicing will be limited with these types of reports.
Review Engagement Statement
Financial statements that have been reviewed by an accountant, who performs limited procedures to provide moderate assurance that the financial information is free from material misstatements.
Unlike an audit, which involves a deep investigation and high level of assurance, a review engagement involves analytical procedures and inquiries to ensure the financials are plausible and consistent.
These statements are often used by lenders, investors, and surety companies when they require more assurance than a compilation but do not need a full audit.
For the majority of contractors, this is the level of accountant prepared reporting needed to obtain bond facilities – even in the 100s of millions of dollars.
Audited Financial Statements
This level of year-end statement is almost never requested from bonding underwriters, but it is a welcome bonus if a contractor has these available to maximize their bond facilility.
5. Withholding details or not being transparent with your broker
Your broker is on your side – they want you to get the bonds. They will work with you to convince underwriters to issue the bonds you need. Be transparent with your broker.
At Bond Connect we specialize in negotiating bonding terms for your company to ensure a prosperous future and continuous support when bonds are needed. Establishing a long-term relationship with a surety brokerage that matches your construction bond goals is essential and we specialize in ensuring an appropriate fit for your surety bond program.
Maintaining a healthy balance sheet and a strong cash flow can significantly improve your chances of securing a bond facility at favorable rates. Transparency is key—be ready to discuss any financial weaknesses, share structure, ownership and succession planning openly.
A strong relationship with your broker can pay off when you need to secure a bond quickly, and help keep track of your current bonding capacity to factor it into new bids. These mistakes can easily be avoided by discussing them with your broker:
- Not being aware of your bonding capacity limits
- Taking on too many projects at once, exceeding bonding capacity
- Failing to update your broker after completing projects
- Generally, not keeping open communication with your broker
We often find that contractors end up using their insurance brokers as their surety bond representatives as well. This is not ideal as insurance professionals do not carry the same expertise needed for managing bond facilities.
Insurance brokers may also end up placing surety bond business with an underwriter with less competitive rates because they’ll get a bonus for aggregating business with a specific insurer. Not ideal for the contractor.
Don’t worry – we have your back at Bond Connect!
Overview of Mistakes for Contractor Surety Bonds
Contract bonds, such as performance bonds and L&M payment bonds, are commonly required to secure large construction projects as well as contracts in other industries.
A contract bond facility allows a contractor to bid on and secure multiple projects without going through the initial extensive underwriting process each time a bond is needed.
Please note that even once a bond facility is setup, each project is still considered by underwriters prior to having bonds issued for it.
There is a short form application for this called a Bond Requisition. Don’t worry, part of our roles as your bonding broker is to ensure this process is as smooth as possible.
Remember to always review the project contract carefully to determine the exact bonding requirements. Your broker can always assist with this to ensure adequate bond wordings, etc.
Misunderstanding which bond is required for a project can result in delays or legal issues.
At Bond Connect, we help contractors navigate the complexities of the surety bond application process, ensuring they avoid these common mistakes. With the right guidance and preparation, you can secure the bonds you need to succeed in the construction industry.
